January 15, 2005
WASHINGTON, D.C.—A new study from the Tax Foundation examines state lotteries and finds them contrary to sound state tax policy. The study is No. 46 in the Tax Foundation Background Paper series, “Lotteries and State Fiscal Policy” by Alicia Hansen.
Lotteries Spread as Revenue Source
The virtues and defects of lotteries have become more important as states have increased their reliance on lottery revenue. Oklahoma has just approved a lottery referendum and will become the 41st state to sell lottery tickets.
Many existing lotteries are expanding into new forms such as video gaming devices. In Fiscal Year 2002, South Dakota raised over 7 percent of its own-source revenue selling paper and video lottery tickets, and the nationwide average in states with a lottery was 2.2 percent of own-source revenue (not counting money from the federal government).
The average American spent more on lotteries in 2002 than on reading materials or movies. Lotteries are now the most popular form of gambling in the U.S., with more than half of Americans playing the odds in any given year.
In Fiscal Year 2003, total spending on lotteries was almost $45 billion, or $155 for every man, woman and child in the United States. Roughly 31 percent of this, or almost $14 billion, went into state coffers.
According to Hansen, this lottery growth is a disturbing trend. State legislators looking to boost tax revenue would do well to consider other sources that are more consistent with principles of sound tax policy.
“State-run lotteries make state tax systems more regressive, less transparent, and less economically neutral,” said Hansen. “For all these reasons, the lottery is an example of poor tax policy.”
A “Voluntary” Tax?
The study addresses a common fallacy used to promote lotteries: the idea that lottery revenue is not actually tax revenue since playing the lottery is voluntary.
“A mandatory tax on a voluntarily purchased lottery ticket is still a tax,” said Hansen, “just as any sales tax or excise tax is a mandatory tax on voluntarily purchased goods and services.”
The Census Bureau assigns lottery revenue the innocuous designation “miscellaneous revenue” in its reports on state taxation. As a result, state lawmakers establish and expand lotteries without admitting that they are raising taxes.
Government Agency or Private Enterprise?
States call their lottery revenue neither taxes nor miscellaneous revenue, but “profits.” This term from the business world reflects a common perception among lottery officials that lotteries are more like a business than a government agency.
While some lotteries are run by regular employees of the state’s revenue department, many are run by independent agencies, and some are only quasi-public. This independence is allegedly necessary to maximize “profits” and sometimes includes private-sector salaries like the Tennessee Lottery CEO’s salary of $350,000 plus bonuses that, contingent upon sales, could bring compensation to $752,500—more than the governor’s.
Aggressive advertising campaigns for lotteries are unique in state government operations. Although lotteries themselves were illegal until 1964, and advertising them was banned until 1975, advertising has now made lotteries one of the most visible activities of state government. In addition to the free advertising that lotteries get when TV stations and newspapers report each day’s winning numbers, lotteries spend significant sums promoting new and existing games, $400 million in 1997.
“Lotteries are unique among government agencies in that they actively encourage participation in an activity that they prohibited only 40 years ago,” Hansen points out. “This raises the question of whether profit-maximization is compatible with the goals of responsible government.”
Comparing Lottery Revenue with Other Taxes
Lotteries, like other forms of taxation, should adhere to basic principles of sound tax policy like transparency and neutrality. But according to the study, lotteries violate these principles.
“Taxes should be transparent, that is, clear to taxpayers,” said Hansen. “Taxpayers should understand what is being taxed and at what rate.”
Since state governments refuse to identify lottery “profits” as taxes and advertise the lotteries as recreation, not tax collection, the tax is implicit and transparency is impossible.
Nor are lottery taxes economically neutral. A neutral tax system is one that doesn’t encourage the consumption of one good over another, thereby distorting consumer spending. However, lottery tickets are singled out for a higher tax rate. This causes economic distortion and lowers the payout rate—the amount that gamblers win as a percentage of the money they bet.
A third problem with lotteries is that they’re regressive, meaning that the poor bear a disproportionately heavy share of the tax burden.
“Numerous studies have shown the lottery to be a regressive form of taxation,” said Hansen.
For example, the National Gambling Impact Study Commission found that in 1997, although people of all incomes played the lottery, players with incomes under $10,000 spent almost three times as much as those with incomes over $50,000.
The Tax Foundation has monitored tax policy at the federal, state and local levels since 1937. Best known for its annual calculation of Tax Freedom Day®, the Tax Foundation is a nonprofit, nonpartisan 501(c)(3) organization.
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Media Contact: Bill Ahern (202) 464-5101